The Top 10 Reasons to Hold Gold, Bar None!

With gold working up the gumption to walk through $1,000 for the third time in this historic climb, Fools are encouraged to step into a broader understanding of the fundamental factors behind the metal's gilded outlook.

6. Inflation LoomsOf all the reasons to hold gold, the debate over potential scenarios for the onset of inflation remains the most unnecessary obstacle to understanding gold's outlook. We must not let the inflation debate muddy the waters for gold, since frankly, all scenarios are now supportive of gold. Whether you're convinced we'll see runaway hyperinflation, a deflationary spiral, or stagflation, the direction for gold is unaffected.

Washington has shown its cards, Fools. A deflationary spiral clearly was deemed the most unacceptable consequence of this crisis, resulting in an implied guarantee that further economic contraction would be met by ever-increasing sums of stimulus. In this policy environment, therefore, inflationary forces do not hinge upon economic stabilization. While it's true that recovery could exacerbate inflationary forces as liquidity starts circulating through the economy, inflation can certainly take hold without it … and I believe it will. I view looming inflation as a currency event rather than an economic event, and see stagflation as a likely outcome. No matter which scenario unfolds, though, this environment is ripe for gold.

7. A question of confidenceWhen Treasury Secretary Tim Geithner told a group of students in China on Monday that their country's U.S. dollar holdings are "very safe," the crowd broke into laughter. Holding more than $1 trillion in U.S. debt, China's concerns are justified. In March, Prime Minister Wen Jiabao admitted he too was "concerned about the safety of our assets." In stark terms, a former Chinese central bank advisor warned Monday that "another financial crisis triggered by a dollar crisis could be inevitable" if the U.S. fails to reduce deficits and increase savings. Hou Huimin of the China Gold Association relates the discussion back to gold: "the US dollar … may retreat from being the international reserve currency. If that happens, whoever holds gold will be at an advantage."

As revealed in April, China is indeed holding more gold … 1,054 tonnes of it. Precious metals analysts see China's accumulation signaling a "broader shift in central banks' attitude towards gold," potentially "re-igniting gold's relevance as a monetary asset." Meanwhile, China is leading a charge to increase the role of its own currency in international trade, instituting $95 billion in dollar-dodging currency swaps with nations from South Korea to Argentina. A bi-lateral trade deal with Brazil may also seek to skirt the greenback, while up to 50% of China's trade with Hong Kong could be conducted in yuan by 2010. The ascendancy of China's currency on the international stage can be seen as a challenge to the dollar's de facto reserve currency status. In fact, the BRIC countries (Brazil, Russia, India, and China) presented a unified front at the G20 summit in April, proposing a new global reserve currency to replace the dollar, based upon a basket of currencies … including gold. All of these developments stem from diminishing confidence in the U.S. dollar as a product of Nos. 1 through 6 above.

8. Gold remains cheapThen-Fed Chairman Paul Volcker faced some tough challenges containing inflation in the late 1970s, but in terms of scale, his predicament was undeniably tame compared to the pickle we're in today. And yet, gold remains more than 50% below the inflation-adjusted peak from 1980. Given the fundamental deterioration of the dollar's outlook over the past year, I consider gold primed to establish last year's high above $1,000 as a new long-term floor.

9. Gold is relatively scarceUnlike paper money, gold cannot be created out of thin air. Despite a 7% rise in overall demand in 2008, including a 27% surge from bullion ETFs like SPDR Gold Shares (NYSE: GLD) , global mine production fell 3%. Successive market shocks, from soaring costs to crashing prices, disrupted the global pipeline of mine development projects. Low-cost producers like Goldcorp (NYSE: GG) were driven to quarterly losses, while operational snags plagued South African miners like Gold Fields (NYSE: GFI) and AngloGold Ashanti (NYSE: AU) . All told, Randgold Resources (Nasdaq: GOLD) CEO Mark Bristow indicated last December that global gold supply could contract 15% over the next five years as a result of insufficient investment in future supply. Poised for some very timely organic production growth, I continue to view intermediate miners Yamana Gold (NYSE: AUY) and Agnico-Eagle Mines (NYSE: AEM) as substantial long-term investment opportunities.

10. The ultimate safe havenI have held no punches in my assertion that the ongoing equity rally is fundamentally unsustainable given the deteriorating condition of the domestic economy. During the last market sell-off, investors flocked to U.S. Treasuries in droves as a conventional safe haven. As concerns mount over looming inflation and a damaged dollar, however, I believe that investors will increasingly turn to gold as the ultimate safe haven.

The above 10 reasons to hold gold provide a timely primer on the metal's fundamental outlook. I expect substantial volatility going forward, so I caution against trying to time short-term movements. While I lament the unfortunate circumstances that would take us there, I expect a substantial increase in the price of gold to offer healthy gains and critical protection for the well-positioned investor.

Gold is a hot topic on the blogs at Motley Fool CAPS. Join the free service today and see just how many Fools are taking the long view when it comes to investing in gold. The"Gold" tagat CAPS lists 40 potential investments, and you'll find Christopher's comments on most of them.

Comments from our Foolish Readers

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Thanks for your insight, Chris! Have you (or anyone else at TMF) ever thought about maybe posting some of the downsides to owning gold so that people can get a realistic idea of what they're getting into? You've established an excellent pro-gold case and I think an opposing viewpoint might help investors understand the playing field a little better.

In response to dudemonkey, I think the pros greatly outweight the cons when it comes to investing in gold. I believe the biggest drawbacks to gold as an investment are that gold prices tend to be volatile and gold does not pay dividends or interest.

Jimmy2008, That is a complicated question. I believe that the bull market for precious metals has several years left in it, with substantial upside along the way. That being said, we are back at this critical $1,000 juncture, where efforts to trade the metals downward may well kick in again. Precious metals are extremely volatile, and I do not advise trying to predict short-term movements. I have suggested to others that in the context of a multi-year up-trend, investors may look back at $50-$100 swings in the price of gold as quite insignificant in the larger scheme.

dudemonkey, It's a fascinating suggestion, but as MiamiBoy1 suggests I'm not sure I could fill an entire article with a negative case for gold. There's the famous volatility, and I believe some well-funded entities exert quite an impact on the market, but apart from those drawbacks I could find myself at a loss for words. :)

Actually, though, fellow Fool Nick Kapur has run this article with a negative view on gold as an investment:

What happens if a new world currency is developed that is somehow pegged to gold? The price of gold used to be regulated and didn't change for decades and decades. If this scenario plays out, it would be more likely for gold to go to $100 than for the price to stay anywhere near $1000.

Actually, given the enormous expansion of the United States' national debt, the federal reserve's balance sheet, and the current account deficit, any attempt to peg the dollar to gold would necessarily involve a price far, far higher than $1,000.

Yes, the dollar used to be pegged to gold, but the peg was removed because it constrained spending. Due to the spending that has taken place since, gold would have to settle much, much higher before a peg to the USD or even a basket of fiat currencies could reasonably be established.

I would start the case against gold with "it's not money any more since no major currencies are pegged to it." If you look at it from that perspective, gold isn't even a commodity (it's not really used for much outside of India and Ole Dirty Bastard's dentist) which makes it a pure speculative play. I realize that central banks stockpile gold, but I don't think anyone reading this article owns a central bank nor do most of us have enough money or gold to really move a central bank's needle. Since buying gold is speculation (from this perspective), gold speculators are free to debate whether it's due to go to $10,000 an ounce or $100,000 an ounce and no one can really argue with their logic since they make the fundamental assumption that you believe in the value of gold.

From there, I would venture into the area of "gold doesn't earn any interest, and it's not liquid." Gold is only convertible into goods and services through currency (and those conversions involve the frictional costs of transactions fees). This means that your net worth can only realistically go down when you buy gold. Since gold is not really consumed, I don't see how it can go any direction except down in real terms.

Basically, the only way to make money in gold is to buy it and hope that someone else is willing to buy it for more.

I might end the article with the opportunity costs of buying commodities like oil, silver, agriculture, nickel, copper, iron, or platinum that follow the normal rules of supply and demand. These are more predictable commodities and therefore pass the first test of whether they're investments or speculation. There's the opportunity cost of converting your dollars into a more stable currency. There's the opportunity cost of converting your dollars into equities either here or abroad that CAN earn interest.

I guess my last con about buying gold is the people who are buying gold. While they have very good and well-reasoned insights, none of them seem able to see any possible downside to buying gold even at $1000 an ounce. I suspect that many of these people are willfully blind to the risks. It just makes me suspicious of their advice, as any rational investor should be.

I could be wrong, for sure, but I think I'm going to sit this one out. I see the inflation on the horizon but I don't understand gold so I'm forced to look at other options.

Despite our difference of opinion on this topic, I'm very glad to have a place to bring this up and I'm even more glad to see that there is someone out there who is doing so much research into commodities and commodity companies. Thanks for your hard work, Chris!

Don't construe my post as a knock on Chris/TMFSinchiruna's analysis. I'm just saying "I don't get it." I'm interested in commodities and I spent a few weekends going back over his articles and blogs for the past few years and I still am not seeing gold the same way he does.

Your alternate perspective is very much appreciated, and I'm sure it's appreciated by many others out there who may also be skeptical about gold.

As one who has devoted many thousands of hours studying the case for gold with an objective mindset (truly), I do feel I've developed a comprehensive understanding of gold on an historical basis, on a technical basis, and of course an a fundamental macroeconomic basis. The knowledge I have acquired assures me that gold remains a currency despite this 36-year experiment with floating fiat currencies. To assume otherwise, in my opinion, is to assume that this financial crisis and the resulting impairment of the U.S. dollar does nothing to place the unbacked fiat model at risk. History is wonderful teacher in this case, since every prior experiment with unbacked fiat currency has ended poorly. In that vein, I urge Fools not to ignore the wisdom that can be gleaned from this nation's own founding fathers (see link below). With China buying and Russia pushing for gold's inclusion in a new currency basket, I think the evidence points to gold's continued role as a currency.

I'm not following your second paragraph. The idea that net worth can only go down since gold is only convertible to goods and services through paper currencies ... you'll have to fill in those dots for me. :) If you convert out of a paper currency when it's strong, and back into it when it's very weak, you in fact can realize a gain in net worth (purchasing power).

As to paragraph 3 and several others, it seems clear you're focusing exclusively upon the case for gold bullion. The vast majority of my gold exposure is through gold mining equities, which offer leverage to price increases in gold through ballooning profit margins. The path for miners has not been an easy one, but in $1,000+ price territory I believe the group will perform well.

"There's the opportunity cost of converting your dollars into a more stable currency." Dudemonkey, my friend, there is no more stable currency than gold. That is precisely why central banks hold it. You do concede, meanwhile, the downside risks for highly indebted floating fiat currencies ... do you not?

I can assure you 100% that I and many other precious metals investors that I know are not "willfully blind" to the downside risks for gold. If I had not conducted a thorough analysis that included an assessment of downside risks, I never would have been able to stand by and watch that brutal correction of 2008/2009 without bailing. Gold corrected more than 33%, silver 50%, and mining stocks plummeted further still (because leverage is a pendulum that swings both ways). I held fast to my positions because I remained confident in the fundamental pillars of my investment thesis, and thus was able to keep the correction in context.

With all that said, please let me say again how much I appreciate the healthy debate, how much I respect your well-expressed opinion, and that I too am very glad to have a place to discuss these issues in an open and respectful environment. I'll keep plugging away on the research, and look forward to your continued readership. Fool on!

While I own, silver bullion for many of the reasons that Chris mentioned, I would agree with others that liquidity would be a major disadvantage. Now owning goldmining stock gets around this as it trades as easily as any other stock, but trying to sell your stake in physical assets is not as easy as clicking submit trade in your brokerage account, buying maybe but trying to sell it back is your looking at a pretty steep cut from the spot price..

So maybe a better way to think of your metal strategy is to control access to gold through stock or futures rather then to "hold" gold in the form of physical assets.

Thanks very much for your comments. While it's true that selling bullion presently fetches prices beneath spot, that may cease to be the case if the physical market for bullion tightens sufficiently.

By far the bigger issue working against physical bullion ownership, in my opinion, is the present U.S. tax policy that treats gold and silver bullion as collectibles ... and as such subject to the collectibles capital gains tax rate of 28%. This is a big-time bummer, but in my opinion is still outweighed by the benefits of having some bullion exposure as insurance against some of the worst-case scenarios regarding the USD. That being said, I still view mining stocks and royalty companies as quintessential components of a well-honed precious metals basket.

another gold bug...funny the chinese laughed yet continue to BUY. The are probably the reason the dollar doesn't get too weak, they are pressuiring us to keep a handle on it. Gold probably will go over 1000 but may be too early as inflation isn't really an issue right now...depends on how far out investors are looking, if they dump gold and buy equities gold could go under 900 again to 875 range ( BUY ) if not and they are patient it may very well do what you say....too many different opinions on gold, some say 2000 other are saying back to 700's? who to believe....?

I bought Yamana gold in the 3's ...no brainer but sold in the 9's and it was around 11.75 last I looked..lol still cant complain about a near triple

Then-Fed Chairman Paul Volcker faced some tough challenges containing inflation in the late 1970s, but in terms of scale, his predicament was undeniably tame compared to the pickle we're in today. And yet, gold remains more than 50% below the inflation-adjusted peak from 1980. Given the fundamental deterioration of the dollar's outlook over the past year, I consider gold primed to establish last year's high above $1,000 as a new long-term floor.

Yet Gold can never seem to sustain itself at $1000 an ounce..mayeb this year it will, but makes one wary buying near $10000

I totally agree with all of your reasons that gold should be part of anyone's investment portfolio.It makes total sense. However, I do not see these reasons compelling enough to sell the ranch and buy gold. We are approaching $1,000 and ounce for the third time in history.Given today's uncertainties there are also risks. Therefore, gold should be part of a well-balanced, diversified portfolio offering a mixture of equities, bonds, international, and cash.

Great comments, though I still refute the title of 'goldbug'. :) I'm merely a pragmatic investor whose reading of the macroeconomic landscape has instructed a move away from USD exposure, and whose resulting analysis of gold and silver revealed their selection as the most rational vehicles for protection from sustained dollar devaluation.

"Gold can never seem to sustain itself at $1,000."

Let's not overplay the significance of the $1,000 mark either. Gold has tested this level exactly twice since March of 2008 ... there are limits to the numbers of conclusions we can draw from such a short duration. From a technical standpoint, secular bull market advances frequently test meaningful resistance twice before breaking through on the third attempt. Certainly in the case of gold, this pattern can be seen when prior resistance points fell.

Remember, it's all about gold as priced in USD. Gold doesn't change ... it's still the same yellow metal it's always been ... what's in flux is the currency in which it trades. Ask not what's different about gold this time ... ask what's different about the dollar this time.

investorwit,

Thanks for bringing this up. Every investor must decide for him/herself an appropriate and comfortable allocation. To be sure, I feel that the common wisdom of 5-10% of a portfolio in gold (and silver) might not carry the same wisdom as it once did given the circumstances, but that's not to be taken as any plea for Fool's to sell the ranch. :) I recognize that few would feel comfortable with my heavier allocation, especially given gold's ruthless volatility, but beyond suggesting that the conventional wisdom deserves a little modification, I remain silent on the issue of allocation. That is a decision for each individual investor to make.

Speaking of questioning the conventional wisdom, please consider this article I wrote last year:

"I'm not following your second paragraph. The idea that net worth can only go down since gold is only convertible to goods and services through paper currencies"

I can't really speak for dudemonkey, and am on your side, really, but I think I see what he means.

If you think of your net worth, as measured in gold, which is probably the most accurate measure of wealth, he's right. As you correctly say (and he complains about) gold is a store of wealth, not a wealth generator. So transacting into and out of that store has friction which reduces your net wealth, naturally, a little. Looking at a recent ad for gold bullion (the Perth Mint Certificate Program), and they charge 2.25% to buy in (+$50, $10K min) and 1.25% to sell out, so you're out about 4% guaranteed.

Whether that is worth it depends on what your wealth will do measured in dollars or other currency instead of gold. But on the face of it, he's right.